JBC: Oil Market to Remain in Surplus Through 2017

Although global balances have tightened in the past several months, the oil market should remain in surplus for the rest of this year and throughout 2017. Fundamentals will see some periods of global net stock draws, but on average, over the next year and a half, supply is expected to remain ahead of demand, according to a major energy research firm.

“Clearly, the market is rebalancing. It’s a tighter market and it’s tightening, but it’s not exactly tight just yet.”

Analysts at JBC Energy say there are more risks to the upside for supply than demand. “Clearly, the market is rebalancing. It’s a tighter market and it’s tightening, but it’s not exactly tight just yet,” Julius Walker, Senior Consultant at JBC, told The Fuse at the firm’s offices in Vienna.

Despite the low price environment, supply growth is still occurring in many non-OPEC and OPEC countries. In the U.S., shale production has declined but the fall there is not enough yet to balance the market, said Walker, who is more optimistic than other forecasters in the outlook for shale. JBC sees U.S. total crude oil production declining by .570 mbd in 2016 and a slower .370 mbd next year, after which it grow again. With prices having rebounded to the $50 level, the fall may not even be so pronounced. The rig count has stabilized, there’s been an uptick in drilling activity in North Dakota, the home to the prolific Bakken fields, and there’s anecdotal evidence that service companies are starting to hire again.

“While US shale will clearly decline this year, there are various other sources of supply growth,” said Walker. “We see just as many upside surprises to supply as we do to the downside for supply.”

In other non-OPEC producers such as Russia and those in the North Sea, output has actually grown since crude prices tumbled, and sustained growth is expected in Canada and Brazil. Meanwhile, in OPEC, three main producers—Iraq, Iran and Saudi Arabia—all have the potential to boost production over the rest of the year. Even Libya could see surprise production increases should a meaningful political solution occur in the country.

“The Saudis are just as concerned about prices above $50 as they are about prices falling below $30.”

Walker does not see OPEC taking action this week with either a freeze or a production cut, particularly since prices have rallied to $50, which may be the price level at which some shale output is workable again. Saudi Arabia—OPEC’s de facto leader—has little if any motivation to take action to shore up prices.

“The Saudis are just as concerned about prices above $50 as they are about prices falling below $30,” said Walker, noting that higher levels would simply stimulate production elsewhere.

The Saudis, now pumping around 10.2 mbd, could actually increase output. “It stands to reason that Saudi Arabia may try to up their production in line with their rising domestic demand,” said Walker.

OPEC’s relevance

With the upcoming meeting in Vienna unlikely to bring about any action on part of OPEC and the cartel not cutting production to rebalance fundamentals, a number in the analyst and journalistic communities have said the group is irrelevant. Walker cautions against making such bold declarations.

“The organization has been around for 56 years, and they’ve had worse crises than what they’re going through now,” Walker said. “They’ve always held together. Many of the players in OPEC increasingly think long term, and when circumstances change a few years down the road, they may reassert themselves to manage the market.”

“Many of the players in OPEC increasingly think long term, and when circumstances change a few years down the road, they may reassert themselves to manage the market.”

The last time OPEC took coordinated action to cut supply to shore up prices occurred in 2008-9 when the market collapsed from $147 to $32. But in 2014, when prices tumbled amid a supply glut caused by U.S. shale, OPEC did not throttle back, and in fact, raised production. JBC analysts point out the difference between the two periods. In 2008, demand collapsed as a result of the global financial crisis, but in 2014, the price fall stemmed from supply-side issues. “The situation in 2014 was different in the sense that this time OPEC was confronted with a structural oversupply with the emergence of shale and the reasonable expectation was that a production cut would not be a cure for the oil market, but rather a blessing for high-cost producers,” JBC says.

OPEC should consider resuming its role as a force to stabilize fundamentals in order to build a sizable cushion of spare capacity and stimulate investments so there’s no supply gap years down the road from today’s capital expenditure cuts.

JBC believes that OPEC should consider resuming its role as a force to stabilize fundamentals in order to build a sizable cushion of spare capacity and stimulate investments so there’s no supply gap years down the road from today’s capital expenditure cuts. Any future price spike could ultimately be counterproductive for the group. “Any violent upswing [in price] will cause herds of people to order a Tesla 3 or similar electric car models—without the need for policy guidance,” JBC says in a recent note. “To prolong the reign of oil by pushing out peak demand and fostering healthy investment conditions, it is in the vital interest of OPEC to support a moderate and stable price regime.”

However, the Saudis appear reluctant to shoulder the burden of being a swing supplier in order to stabilize fundamentals on their own.

Demand issues

Besides the upside potential with supply, demand issues will also keep the market from quickly rebalancing. Although JBC sees demand rising by 1.3 mbd in 2016, that figure is weaker than the 1.8 mbd for last year, and growth is pegged at 1 mbd in 2017.

There are a couple of reasons for the weaker growth. First, the stimulus from the price collapse from $115 in mid-2014 to below $30 earlier this year has already filtered into consumer behaviour and is not likely to give an extra boost—especially now that crude prices have risen again. Second, a number of economic risks are currently capping demand and threatening growth. One obvious concern is China, where GDP growth has been grinding lower and is targeted at a relatively weak 6.5 percent.Another is Brazil, where demand was growing at a blistering pace but is now contracting amid a weaker economy and political turmoil. Third, demand in emerging markets has shifted from middle distillates—demand and heating oil—to light distillates. This shift, particularly apparent in China and also becoming a trend in India, is largely from less infrastructure projects being built, lower industrial demand, and a decline in long-haul trucking. Both countries are the largest sources of demand growth for global oil markets, which are now contending with fuel efficiency gains in both OECD and non-OECD countries.

These trends have major long-term ramifications for long-term oil consumption patterns. “2016 could be the last year we see demand growth greater than 1 mbd,” Walker told The Fuse.

Too much bullishness?

“We’re a little concerned with this very strong bullishness. The supply side could take a lot longer to adjust, and there could be more surprises on the upside for production.”

Some in the analyst and trader community see the combination of the current supply outages, technical strength, buying in the paper market by hedge funds and other investors, and massive capex cuts as the beginning of a bull run.

JBC is more sober, expecting prices to remain flat through this year and rises slightly in 2017.

With the large stock overhang currently in the market and the surplus expected to persist through 2017, Walker is surprised by the current market sentiment, which has shifted dramatically since the beginning of the year, and warns about overhyping recent oil price gains. In fact, the market could be heading for a temporary downward correction, and it’s important to be cautious.

“We see quite a lot of bullish sentiment now, which is a bit of a surprise,” said Walker. “We think people read a bit too much into the decline of U.S. production, and assume the same is occurring elsewhere. Some extrapolate that the rebalancing is inevitable because the U.S. is declining. We’re a little concerned with this very strong bullishness. The supply side could take a lot longer to adjust, and there could be more surprises on the upside for production.”

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The Fuse is an energy news and analysis site supported by Securing America’s Future Energy. The views expressed here are those of individual contributors and do not necessarily represent the views of the organization.

Issues in Focus

Safety Standards for Crude-By-Rail Shipments

A series of accidents in North America in recent years have raised concerns regarding rail shipments of crude oil. Fatal accidents in Lynchburg, Virginia, Lac-Megantic, Quebec, Fayette County, West Virginia, and (most recently) Culbertson, Montana have prompted public outcry and regulatory scrutiny.

2014 saw an all-time record of 144 oil train incidents in the U.S.—up from just one in 2009—causing a total of more than $7 million in damage.

The spate of crude-by-rail accidents has emerged from the confluence of three factors. First is the massive increase in oil movements by rail, which has increased more than three-fold since 2010. Second is the inadequate safety features of DOT-111 cars, particularly those constructed prior to 2011, which account for roughly 70 percent of tank cars on U.S. railroads. Third is the high volatility of oil produced from the Bakken and other shale formations, which makes this crude more prone towards combustion.

Of these three, rail car safety standards is the factor over which regulators can exert the most control. After months of regulatory review, on May 1, 2015, the White House and the Department of Transportation unveiled the new safety standards. The announcement also coincided with new tank car standards in Canada—a critical move, since many crude by rail shipments cross the U.S.-Canadian border. In the words DOT, the new rule:

Since the rule was announced, Republicans in Congress sought to roll back the provision calling for an advanced breaking system, following concerns from the rail industry that such an upgrade would be unnecessary and could cost billions of dollars. The advanced braking systems are required to be in place by 2021.

Democrats in Congress have argued that the new rules are insufficient to mitigate the danger. Senator Maria Cantwell (D-WA) and Senator Tammy Baldwin (D-WI) both issued statements arguing that the rules were insufficient and the timelines for safety improvements were too long.

The current industry standard car, the CPC-1232, came into usage in October 2011. These cars have half inch thick shells (marginally thicker than the DOT-111 7/16 inch shells) and advanced valves that are more resilient in the event of an accident. However, these newer cars were involved in the derailments and explosions in Virginia and West Virginia within the past year, raising questions about the validity of replacing only the DOT-111s manufactured before 2011.

Before the rule was finalized, early reports indicated that the rule submitted to the White House by the Department of Transportation has proposed a two-stage phase-out of the current fleet of railcars, focusing first on the pre-2011 cars, then the current standard CPC-1232 cars. In the final rule, DOT mandated a more aggressive timeline for retrofitting the CPC-1232 cars, imposing a deadline of April 1, 2020 for non-jacketed cars.

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DataSpotlight

The recent oil production boom in the United States, while astounding, has created a misleading narrative that the United States is no longer dependent on oil imports. Reports of surging domestic production, calls for relaxation of the crude oil export ban, labels of “Saudi America,” and the recent collapse in oil prices have created a perception that the United States has more oil than it knows what to do with.

This view is misguided. While some forecasts project that the United States could become a self-sufficient oil producer within the next decade, this remains a distant prospect. According to the April 2015 Short Term Energy Outlook, total U.S. crude oil production averaged an estimated 9.3 million barrels per day in March, while total oil demand in the country is over 19 million barrels per day.

This graphic helps illustrate the regional variations in crude oil supply and demand. North America, Europe, and Asia all run significant production deficits, with the Middle East, Africa, Latin America, and Former Soviet Union are global engines of crude oil supply.